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Facts
The Assessing Officer (AO) made an addition of Rs. 2,21,50,906/- under Section 56(2)(viib) of the Income Tax Act, 1961, to the assessee's income, alleging incorrect valuation of share premium received on preference shares as per Rule 11UA. The assessee had issued preference shares to M/s Enlightened Consultancy Services Private Limited and provided a valuation report using the Dividend Discount Valuation Model (DDVM). The Commissioner of Income Tax (Appeals) deleted the addition.
Held
The Income Tax Appellate Tribunal (ITAT) upheld the CIT(A)'s decision, concluding that the valuation of shares is a technical and complex issue requiring expert opinion. The Tribunal found that the AO failed to demonstrate that the expert's valuation report was fundamentally erroneous or based on incorrect facts, and did not provide an alternative valuation. The ITAT emphasized that the method of valuation is the assessee's choice, and the AO cannot change it without credible material issues.
Key Issues
Whether the addition under Section 56(2)(viib) related to share premium on preference shares was correctly deleted by the CIT(A), specifically regarding the validity and acceptance of the valuation report and method (DDVM) adopted by the assessee as per Rule 11UA.
Sections Cited
143(3), 56(2)(viib), 11UA
AI-generated summary — verify with the full judgment below
Income Tax Appellate Tribunal, DELHI BENCH: ‘H’: NEW DELHI
Before: SHRI GS PANNU & SHRI ANUBHAV SHARMA
This appeal has been preferred by the Revenue against the order dated 08.07.2021 of Commissioner of Income Tax (Appeals)- 27, New Delhi [hereinafter referred to as ‘Ld. CIT(A)’] in Appeal No.
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. 118/19-20/1239 arising out of an appeal before it against the order dated 27.11.2019 passed u/s 143(3) of the Income Tax Act, 1961 (hereinafter referred as ‘the Act’) by the ACIT, Central Circle-20, Delhi (hereinafter referred as the Ld. AO) for Assessment Year 2017- 18.
The case of assessee was selected for limited scrutiny assessment, and the issue of shares premium received by way of issue of 1513040 shares to Enlightened Consultancy Services Private Limited @ Rs. 20 per shares, including share premium of 10
per shares, was examined. The assessee had claimed that the shares were issued against the unsecured loans received in preceding years from M/s Enlightned Consultancy Service Private Limited. The Assessing Officer considered the facts and was of the view that the assessee has not furnished report from merchant banker with respect to computation and rational behind price of each share for the purpose of Rule 11UA of the Income Tax Rules and made the addition by following observation in para 3.4 of the Assessment Order:
“3.4 In view of the above facts of the case it is clear that provision of Section u/s 56(2)(viib) of the I.T. Act, 1961 is applicable in the Page 2 of 13
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. assessee's case. The amount after computing fair market value of shares as per rule 11UA is Rs. 81,10,640/- (formula for computing fair market value as per rule 11UA is (A-L)*PV/PE). Therefore, to compute price of each share the fair market value as computed above (81,10,640/-) is to be divided by total no. of shares issued (15,13,040/-). Hence, the computation done by AO as per Rule 11UA for price of each share is Rs. 5.36/- (81,10,640/15,13,040/-) as explained above. However assessee has issued 5% Preference share capital @ 20/- therefore Rs. 14.64 (20-5.35) per share is to be added back to the income of the assessee. The assessee has issued 1,513,040 Preference share @ 20 per share i.e. 10/-per share as Share Capital and 10/- per share as Security premium. Hence Rs. 2,21,50,906/- (14.64*1513040/-) is to be added back to the income of the assessee under the head other source according to section 56(2)(viib) of the Income Tax Act, 1961.
In appeal, the same was deleted for which, the Revenue is in appeal, and raising the following grounds;- “1. That the Ld. CIT(A) has erred on facts and in law in deleting the addition of Rs. 2,21,50,906/- u/s 56(2)(viib) of the I.T Act made by AO as assessee was unable to furnish the valuation report supporting his method adopted for determining the value of preference shares.
2. Whether in law and on facts of the case the order of the Ld. CIT(A) is erroneous and not tenable in law and on facts. (a) The Ld. Commissioner of Income Tax (Appeals) is erroneous and not tenable in law and on facts. (b) The appellant craves leave to add, amend any/all the grounds of appeal before or during the course of hearing of the appeal.
Heard and perused the records.
On appreciating the order of CIT(A), it can be seen that CIT(A) has deleted the addition by following conclusion:
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. “5.7 On the basis of above facts, law and legal precedents on the issue, it is observed that (i) There is no allegation of introduction of any unaccounted money through shell companies for subscribing to the NCRPS of the appellant company. (ii) As per Rule 11UA, the prescribed methodology of determination of the Fair Market Value (FMV) of preference shares is not the same as that of the equity shares. (iii) The AO had given SCN for addition u/s 68A, but later chose to make addition u/s 56(2)(viib). (iv) The AO had used one of the methods prescribed for equity shares to determine the FMV of Preference shares, whereas the method prescribed in Rule 11A for preference shares is different. It is pertinent to mention over here that the AO had not given figures used, in the working of formula used with, in the assessment order. (v) During the course of appellate proceedings, the appellant had filed the valuation report from the independent chartered accountant, as prescribed in Rule 11UA, for valuation of the 5% Non Cumulative Redeemable Preference Shares (NCRPS) issued by the appellant company. (vi) The AO had raised two objections in the remand report, on the FMV determination report of an Independent Chartered accountant, which had been discussed above in para 5.5. Even the judicial precedent on the issue cited above, recognise that the Net Asset Value of the company does not reflect the FMV of Preference shares and FMV of these shares had to be done by merchant banker or chartered accountant. Further reference is invited to the comments that "DCF method is a recognised method where future projections of various factors by applying hindsight view and it cannot be matched with actual performance, and what Ld. CIT (A) is trying to do is to evaluate from the actual to show that the Company was running into losses, therefore, DCF is not correct. Valuation under DCF is not exact science and can never be done with arithmetic precision, hence the valuation by a Valuer has to be accepted unless, specific discrepancy in the figures and factors taken are found. Then AO or CIT(A) may refer to the a Valuer to examine the same." Here the Tribunal had held that even the actual future performance not comparable with the projections of DCF cannot be reasons for rejecting the DCF method. The AO is trying to match the past performance on account of dividend on equity shares with the future projections of Page 4 of 13
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. dividend on preference shares, which is not at all comparable due the very nature of the fact that the preference shares get preference in dividend and there are legal implications for non payment of contracted dividends on it. Further there is changed financial structure with infusion of capital through preference shares, due to which the past performance cannot be compared with future performance. There is no place of past dividend declared in the formula for determining future discounted cash flows or even the method used by the AO. Further, as discussed above, the AO had not given any alternate rate or arranged an alternate report to negate the discounting rate used by the independent chartered accountant in DDVM. In my opinion the DDVM is appropriate methodology for valuating redeemable preference shares, wherein the amount of cash flow, period of cash flow and terminal value is known with reasonable certainty. Even in a stable cash flow company, this method gives reasonably valuations of business and equity shares. However, in companies with unstable cash flows, high fluctuations in profits, high growth companies having very high future cash flows, the Net asset Value may be better indication of valuation of equity shares. Further many tribunals, on the issue of valuation of equity shares as per Rule 11UA, had held that the method of valuation used is the choice of the appellant and cannot be changed by AO, without bringing credible material issues in the valuation method used. In these facts & circumstances of the case, it is held that the contention of the AO to determine the valuation of NCRPS on the basis of net Asset Value prescribed for unquoted equity shares is not sustainable. In my opinion, the valuation done as per DDVM is appropriate methodology to determine the FMV of NCRPS in the present case. The appellant had issued the NCRPS @Rs20 per share as per the FMV determined by the report of independent valuer based on DDVM. There are no sustainable material discrepancies pointed by the AO in the report of the independent valuer prepared on DDVM. Accordingly, the addition of Rs. 2,21,50,906/- made by the AO u/s 56(2)(viib) is not sustainable and hereby deleted.
The Ld. DR has supported the order of the Ld. AO and submitted that the assessee had failed to justify the valuation report on the basis of any facts and figures. Taking the bench across the valuation report, it was submitted that the same is not ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. descriptive and does not have many details for analysis, so AO did not have the opportunity to establish its sustainability.
On the other hand, the Ld. Counsel for the assessee has taken the Bench across all the findings, and the observations of the CIT(A) to defend the order of the CIT(A).
After taking into consideration the material before us and the submissions, it comes up that admittedly, the assessee had allotted 5% non-cumulative redeemable preference shares to M/s Enlightened Consultancy Service Private Limited, at the consideration of Rs. 3,02,60,800/- ÷ 15,13,040/- preference share of Rs. 10 each at premium of Rs. 10 each. The dividend rate was agreed at 5% per annum, and redemption period was decided at 20 years. As agreed between the assessee and investor, the said preference shares will be redeemed at premium of Rs. 55 each after a period of 20 years.
Thus, there is no doubt in mind of the bench that the AO had primarily erred in invoking Rule 11UA(1)(c)(b) as unquoted redeemable preference shares, being in the nature of was quasi- debt, have to be valued as per Rule 11UA(1)(c)(c), for which the ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. merchant banker or an accountant’s report is mandatory. The same deserves to be given status of statutory evidence with burden upon the AO to rebut the same with evidences establishing either the report is based on incorrect facts and figures, or otherwise, the valuation method lacks the sanctity to be considered as statutory evidence. As we go through the remand report, whereby the AO has tried to rebut the valuation report, which had come on record in the form of additional evidence available at pages 15-17 of the Paper Book, it comes up that the AO has questioned the Dividend Discount Valuation Model (DDVM) which has used discount factor of 7.67% to arrive at the valuation. The AO submitted that assessee has failed to substantiate the discount figure and supporting documents for DDVM. On behalf of assessee following explanation was given below:
“The Expert has adopted the dividend discount model for valuation of preference share which is the most accepted method for such shares. The dividend discount model tells us how much we should pay for a stock for a given required rate of return. The report of valuation has already been furnished before your Honour through the Learned First Appellate authority. The Rule 11UA of the Income Tax Rules which specifically deal with the valuation of various kinds of shares, in relation to valuation of preference shares provides for as under - "The fair market value of unquoted shares and securities other than equity shares in a company which are not listed in any recognized stock exchange shall be estimated to be price it would fetch if sold in the open
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. market on the valuation date and the assessee may obtain a report from a merchant banker or an accountant in respect of which such valuation" As far concerned, the expert had considered Dividend Discount Method to arrive at the fair market price of 5% Non-Cumulative Redeemable preference shares, redeemable after 20 years at premium. Therefore, by discounting the dividend and considering the redemption premium at the end of 20th year, the value determined per share will be Rs. 19.86/- per share which was rounded off to Rs. 20/- per share, Discounting factors were taken considering the market discounting rate at relevant time for discounting the dividend by dividend discount method. Working of Fair Value of 5% Non-Cumulative Redeemable Preference Share to arrive at present value of each shares is given below for your reference:
Fair Value ( per Share) 10.00 Dividend Rate 5.00% Redemption period (in 20 Years) Premium at Redemption 55.00 Discount Factor 7.67%
Formula for 1/1+ Discounting Factor for First year Discounting and for all subsequent years, previous factors for year’s discounting factor /1+ various discounting factor) years Years Annual Discount Present Dividend Factor Value
1 0.50 0.93 0.46 2 0.50 0.86 0.43 3 0.50 0.80 0.40 4 0.50 0.74 0.37 5 0.50 0.69 0.35 6 0.50 0.64 0.32 7 0.50 0.60 0.30 8 0.50 0.55 0.28 9 0.50 0.51 0.26 10 0.50 0.48 0.24 Page 8 of 13
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. 11 0.50 0.44 0.22 12 0.50 0.41 0.21 13 0.50 0.38 0.19 14 0.50 0.36 0.18 15 0.50 0.33 0.17 16 0.50 0.31 0.15 17 0.50 0.28 0.14 18 0.50 0.26 0.13 19 0.50 0.25 0.12 20 65.50 0.23 14.94 Total Present Value 19.86 Rounding off 20.00
The CIT(A) has duly taken into consideration this remand and concluded in para 5.4.1. and 5..4.2 as follows:
“5.4.1 The AO in the remand report had mentioned that the appellant is not able to substantiate with evidences the discounting rate of 7.67% used in this DDVM. In the rejoinder replies, the appellant had submitted that this valuation report had been prepared by an expert and the discounting rate s dependent on various factors like Industry norm, nature of business, future prospects, competition, present financials and many external factors. It is observed that in the DDVM method although there are various factors considered by the expert before opting the estimated discounting rate, the most important factor is the weighted average cost of capital (WACC)to the company and internal rate of return of the company. The element of estimated cost of equity in WACC is the area of expert domain. For this reason only, the Rule 11UA mentions that the assessee may obtain a report from a merchant banker or an accountant in respect of which such valuation." The appellant had submitted the valuation report of an independent accountant. In case the AO had any doubts with regard to any presumptions/estimates used in this report, it could have summoned the Independent accountant (valuer) and recorded his statement on these issues. The appellant is not competent to answer on the methodology and values used by the independent chartered accountant engaged as expert for preparing this report. This report has not been prepared by appellant and no evidences are in its possession on any parameters used by the expert in his report. The AO had not pointed any defects in the standard methodology of preparation of this report. The AO had not brought any other report from another prescribed valuer to negate any element of this report. The AO Page 9 of 13
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. had not even estimated the discounting rate, which in her opinion would be appropriate in this case. In these facts & circumstances, it is held that the AO had raised this objection without any alternate working to negate the discounting rate used in the report of the expert. Therefore, this objection of the AO is not sustainable. 5.4.2 The other objection of the AO was that there was no earning to the appellant company in the year 2016 & 2017 and no dividend had been paid in these years, therefore the basic assumption to apply DDVM cannot fulfilled. It is submitted that it is the prerogative of the company to pay dividend on equity shares as per its Dividend Payout Policies. The company may not have paid any dividend to equity shareholders in the past and there are pre conditions for declaring dividend to equity shareholders like existence of profits, free reserves etc. coupled with the dividend policy of the company. The past performance on dividend payments to equity holders cannot be ground for doubting the proposed contracted coupon rate payments on redeemable preference shares on the valuation date Preference shareholders have priority for payment of dividend over-equity shareholders. There is no separate resolution or AGM/EGM required for dividend to preference shareholders. The liability to pay the dividend to Preference shareholders is unconditional, absolute and less restrictive than equity shares. There is possibility that the company may come to profits/super profits for declaring dividend after investment of capital arising out of preference shares. The decision on terms & conditions of the Preference Shares is the prerogative of the investor, who might have done due diligence on business prospects of the company before investing. If the past records of the company only determine the future of the company, then the loss making companies will never be able to find the investors to come out of red. It is pertinent to mention over here that most of the present day e-commerce companies are in huge losses, but are attracting all kind of big investors in various financial instruments of debt & equity. The tax authorities cannot challenge the wisdom & risk taking capacity of the investors. The only past records of dividend to equity shareholders cannot be yardstick to determine the future payment capacity on preference shares. Therefore, this objection of the AO also is not sustainable.”
We are of the considered view that valuation of shares is a technical and complex issue for which the AO has limited authority to tinker the valuation of methodology applied. As we observed at ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. beginning, it being statutory evidence is required to be given presumption of correctness under law as prepared by an expert. It cannot be assailed unless it is shown that valuation was made on the fundamentally erroneous basis or apparent mistake is pointed out and demonstrated. Resting an additional onus of proof on the assessee, apart from tendering the valuation report to substantiate the report also, cannot be sustained. As for this proposition of law, we rely upon following decisions as relied by assessee also:-
i. Miheer H. Mafatlal v. Mafatlal Industries Ltd. ( AIR 1997 SC 506) ii. Rameshwaram Strong Glass Pvt. Ltd. v. ITO [2018- TIOL1358-ITAT-Jaipur] iii. G. L. Sultania and Anr. Vs. SEBI (AIR 2007 SC 2172) iv. ITO v. SBS Properties & Finvest Pvt. Ltd. (ITA 278 and 2164/Del/2008) v. Duncans Industries Ltd. v. State of U.P. and Ors. 2000 ECR 19 (SC) vi. Securities & Exchange Board of India & Ors. [2015 ABR 291- (Bombay HC)] vii. DQ (International ) Ltd. vs. ACIT (ITA 151/Hyd/ 2015) viii. RenukaDatla (Mrs. ) v. Solvay Pharmaceuticals B.V. and ors. [2004] 265 ITR 435 (SC)
ITA No.- 1868/Del/2021 M/s Weldon Polymers Pvt. Ltd. ix. CIT Vs VVA Hotels Private Limited (Madras High Court) T.C.A. No. 670 of 2019 x. Bharat Hari Singhania & Others vs. Commissioner of Wealth Tax & Others 207 ITR 1 (SC) xi. Cinestann Entertainment P. Ltd. vs. ITO (2019) (177 ITD 809) (Delhi) xii. DCIT vs. Pali Fabrics P. Ltd. (2019) (no taxmann.com 310)(mum) xiii. ACIT vs. Subhodh Menon (2019) (175 ITD 449) (Mum).
In the case at hand, where the CIT(A) has co-terminus power to examine the issue threadbare, and after admitting the additional evidences, has drawn the conclusion, that the valuation report as submitted was good enough to explain the valuation, the grounds as raised by the revenue have no substance. Consequently, we are inclined to decide the grounds against the Revenue. The appeal of the Revenue is dismissed.
Order pronounced in the Open Court on 10.06.2024